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Is It Time to Revise Your Sales Compensation Plan?
By Dave Kahle   Printer Friendly Version

If you're paying your sales reps straight commission, you're using an obsolete formula.

If you're paying your sales reps a straight salary, you're also using an obsolete formula.

Both of those formulas are vestiges of an earlier, simpler time. You may be like thousands of other distributors who are using compensation plans that served them well in the past. In the last few years, however, a number of changes in the economic environment have combined to render some of those compensation plans ineffective.

There was a time when your market was growing relatively rapidly. You wanted your salespeople to get as much of that business as they could, with little concern about where it came from. For all but a few distribution industries, that has changed. Even though the last couple of years have been good for many distributors, most will admit to a general uneasiness about the demand for their products. Markets are leveling off, and customers are much more conservative then they used to be. Factor in changes in the dynamics of the marketplace caused by things like the growing power of the mass marketers, and you have several trends that translate to a perceived softness in the market.

Competition is growing. Alternate forms of distribution are becoming stronger and more pervasive. Some industries are seeing telemarketing/catalog companies make inroads. In an attempt to grow, distributors in neighboring geographical areas may be expanding into yours, creating additional competition. And many industries are seeing distributors who previously distributed other items take on product lines which compete with you. Add all this to the equation, and you have a world which is far more competitive and complex then it was.

Another, often overlooked significant change, that has tremendous implications for sales force compensation, is the growing sophistication of sales force software. This gives you the ability to easily measure performance more and more precisely. For example, a few years ago you could probably easily measure sales and gross profits per territory. Anything much beyond that may have been very difficult to get at.

Now, however, many distributors have the ability to easily measure things like gross profits per line of billing, profitability per customer, profitability per product line, and sales costs as a percentage of gross profit per territory.

This increase in information sophistication should be viewed as an opportunity for increases in sales productivity. With this newly acquired ability to measure the results of sales behavior more finely comes the corresponding ability to reward sales behavior more precisely.

All of these relatively recent changes combine to create a climate where smart distributors should take a close look at their current compensation plan to decide if it really is meeting their needs.

There are a number of potential benefits to doing so.
    1. Increase productivity -- and therefore the bottom line. Pressures on margins are not going to go away. It's likely that you'll be averaging a couple points less a few years from now than you do today. If you're going to survive, much less prosper, in that kind of an environment, you'll need to become more productive, to do more with less margin.

    Until recently, you have probably reacted to the need to become more productive by concentrating on internal costs. You've reduced your inventory, streamlined the warehouse, and are probably on your third generation of computer software. But all this time that you've focused internally, you've kept hands off the sales force. It is, in all likelihood, costing you the same percentage of gross profit today that it did a few years ago.

    Yet, the sales force is probably the single largest cost to your company. Look at your P&L statement. Isn't sales force compensation the largest single line item? If you're like most distributors, your sales force costs range around 25 - 35% of gross profit. Doesn't it make sense to at least investigate the potential of changing the compensation plan to make that group more productive? A couple points change in the relative cost of your sales force, and therefore an improvement in its productivity, will drop directly to your bottom line.

    2. Implement corporate strategy. As business becomes more complex and more competitive, the smartest companies are working harder at creating effective strategies. The days of "Go out and sell a lot" are over. Yet most sales compensation programs work against effective corporate strategy because they encourage the sales people to do what is easiest ( sell the easiest item to sell, to the people who most like them) rather than what is in the best interests of the company.

    One of the most common complaints I hear is from frustrated CEOs and sales managers who want to build closer working relationships with certain manufacturers, but who can't get their salespeople to perform adequately on those lines.

    It's often a classic case of the salespeople doing what the compensation program rewards them for (easiest sales) and not what is in the strategic plan.

    Every sales compensation decision encourages and discourages certain behavior. For example, a straight commission plan encourages the quickest, easiest sales. But, it discourages strategic behavior that has a longer-term payoff -- like acquiring new customers or emphasizing certain strategic product lines.

    Straight salary, on the other hand, encourages loyalty, steadiness and attention to service. However, straight salary discourages individual initiative.

    If you want to manage your company strategically, you'll need to ask yourself if your compensation program directly supports your corporate strategy by encouraging the right kind of behavior. If not, it's time to review it.

    3. Free sales managers to become more effective. Different sales force compensation plans require different types and amounts of attention from sales management. You need to make sure that your plan is using your sales management in its most effective way.

    For example, commissioned reps not only require less management than salaried reps, they require a different kind of management. If your compensation program is primarily commission, you, or your sales manger(s) must be more adept at participative, "influencing" type of management. If your plan is heavily weighted in favor of salary, your sales management will spend considerably more time reading call reports, expense reports, and managing political maneuvering on the part of your reps. When your salespeople know that their salary or bonus is dependent on management's judgment, they'll spend a significant portion of their time politically maneuvering for a more favorable evaluation.

    The typical manager may be able to handle 6 - 8 reps who are salaried, and twice that many if they are commissioned. So, one of the variables going into your compensation program has to do with your use of your sales management -- whether that's you or someone else. Since sales management is often one of the highest paid positions in your company, it's a worthwhile exercise to ask yourself if you're making effective use of that resource. Your sales force compensation plan can do more than any other decision to free your sales management up to be more effective.

    4. Attract and retain the right kind of salespeople. One of the most powerful tools you have to attract and retain the right kind of salespeople is your compensation program. Potential salespeople will measure themselves against the compensation formula, and make a decision as to whether or not they can perform adequately under it. Those who don't think they can do it will take themselves out of consideration. They, therefore, make your selection process easier by self-selecting themselves out. Those who see themselves performing under your compensation plan will stay in the interview process.

    I have found that, over time, salespeople gravitate to that compensation situation in which they feel most comfortable. For example, you will rarely have a security-minded salesperson last forever in a straight commissioned position. And you won't see an aggressive money-motivated closer stick around for years in a salaried situation.

    Your plan, then, becomes a tool to retain the kind of salespeople you want.
Self Analysis Here's a self-evaluation tool to help you analyze whether or not you should be revising your sales compensation plan. Simply answer yes or no, and then compare your answers to the list below.
    1. Has it been three years or more since you last made significant changes in your plan?

    2. Does your sales force cost you more than 25% of gross profit?

    3. If 25% or less, are you growing at a rate with which you're satisfied?

    4. Has the percentage of sales force cost compared to gross profit (the number from question two, above) been declining over the last few years?

    5. Are you facing more competition today then a few years ago?

    6. Assuming you have a strategic plan, do you specifically and significantly reward salespeople in a way that directly supports your strategic goals?

    7. Have you been frustrated in the inability of your sales force to support commitments you've made to some of your vendors?

    8. Are you concerned that you may not be utilizing your sales management to its best use?

    9. Do you believe you may not have the right kind of salespeople to see your company successfully into the 21st century?

    10. Are you having a difficult time hiring salespeople who become profitable to the company as quickly as you'd like? If your answers are those in column one below, you have no reason to investigate revising your sales compensation plan. If you have answers in column two, any one may be reason enough to consider a revision. Several answers in column two would indicate a need to consider a revision.
Column One Column Two
1. NO (it has been three years or less) 1. YES ( it has been more than three years)
2. NO 2. YES
3. YES 3. NO
4. YES 4. NO
5. NO 5. YES
6. YES 6. NO
7. NO 7. YES
8. NO 8. YES
9. NO (I'm satisfied with the quality of my 9. YES (I'm concerned) salesforce)
10. NO 10. YES

Your sales force compensation has huge upside and downside potential. On one hand, your plan can be one of your strongest strategic tools. On the other, it is also your biggest ongoing cost. Now is the time to carefully review your plan to take advantage of its upside potential and minimize its downside cost.

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